Global Economic Monitor

Prospects Weekly: A modest recovery in high-income countries is continuing and broadening, Developing-country performance is mixed, Quantitative easing (QE) tapering by the US Federal Reserve led to a sell-off in developing markets

A modest recovery in high-income countries is continuing and broadening, with GDP growth turning positive in the Euro Area, and growth and labor market conditions improving in the US. Developing-country performance is mixed, but growth picked up in several large economies in the second quarter, with the exception of India. An anticipation of quantitative easing (QE) tapering by the US Federal Reserve led to a sell-off in developing markets, but currency depreciation has been concentrated in a few countries and the outflow of portfolio investment appears to have moderated following a sharp initial correction.

A recovery in high-income countries is continuing and broadening. Growth in high-income countries picked up to an annualized 2.3 percent in the second quarter of 2013 from 1.0 percent in Q1. Euro Area growth turned positive in Q2 (after six quarters of contraction) to a still weak annualized 1.2 percent pace, and business confidence continues to improve. This ongoing recovery in the Euro Area is a positive development for global economic prospects. However, Euro Area GDP remains 3 percent below pre-crisis levels and unemployment above 12 percent, with financial stability still an important concern. Notwithstanding the fiscal sequester, US growth picked up to an annualized 2.5 percent pace in Q2 (from 1.1% in Q1), and unemployment claims fell to a near five-year low in August. Japan’s growth is still strong, but slowing (from 3.8% in Q1 to 2.6% in Q2), led by a contraction in investment.

Developing country performance is mixed, but improving in several large economies after prolonged weakness. Brazil’s GDP growth picked up to an annualized 6.0 percent in the second quarter of 2013 (2.6% in Q1), China’s to 7.0 percent (6.6% in Q1), and South Africa’s to 3.0 percent (0.9% in Q1). Industrial production growth in Turkey strengthened to an annualized 5.0 percent pace in the second quarter from 4.2 percent in Q1. Business sentiment indicators suggest further improvement, particularly in China, where the official index rose to its highest in over a year in August. However, growth in India has continued to decelerate, to 4.4 percent (y/y) and only 3.7 percent (q/q saar) in Q2, while industrial production fell by an annualized 11 percent. Since late May, India experienced a sharp currency depreciation, reversal of capital flows, and a further decline in business sentiment, suggesting continued sluggish growth in Q3.

Anticipation of tapering of US quantitative easing has led to a sell-off in developing markets, but currency depreciation has been concentrated in a few countries. Indications of tapering resulted in US treasury yields rising 96 bps since mid-May. The rise triggered a portfolio rebalancing away from emerging market assets, resulting in developing stock markets declining 7 percent. This portfolio re-adjustment was particularly pronounced in June, proceeding at a slower pace in July and August. Currency depreciations are concentrated among a few countries (notably, Brazil, India, South Africa, and Thailand). Overall, 58 percent of developing countries have seen continued appreciation of their effective exchange rate since April, while only 33 percent have seen a decline. Countries with weakening currencies were either commodity exporters; or countries with a combination of external and domestic imbalances (current account deficits, government deficits) and structural impediments to growth (delayed reforms, labor disputes).